Lockhart: Mid 2015 Right Rime For Tightening

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In an interview with Bloomberg’s Kathleen Hays, The Federal Reserve of Atlanta President/CEO Dennis Lockhart warned of the risk of “moving prematurely and snuffing out some progress” if first interest rate increase comes a little big sooner. Lockhart said “I’m more in the camp that patience is called for. I’m holding to the view that mid-year 2015 is probably about the right time for the beginning of a cycle of tightening…I think the conclusions about the strength of the economy at this point have to be taken as tentative conclusions. I’d like to see a bit more evidence accumulate.”

Lockhart went on to say, “it’s very important that we have high confidence that the progress that we expect will be made over the next several months is going to continue.  So I’m trying to build up a sense of confidence in the forecast from the point at which we would begin to adjust forward guidance and then ultimately from the point of liftoff. The forecast from that point is very important.  Liftoff in all likelihood is going to occur well before we actually achieved full employment and probably, you know, less than total certainty on long-term inflation, just because of the span of time. So I want to be confident that the economy’s going to continue on that track.”

To listen to the interview: http://www.bloomberg.com/radio/

Lockhart: Mid 2015 Right Rime For Tightening – Full transcript

KATHLEEN HAYS:  The latest minutes from the Fed, the FOMC, are out.  And it’s an interesting backdrop to me for the conference and discussions here because we know there’s been a big focus on the labor market, unemployment and normalization.

And what we see in the minutes, it seems that this discussion has really intensified.  There’s some people getting a little concerned about the forward guidance.  There’s, what, many people wondering if maybe the first interest rate increase has to come a little bit sooner.

Where are you on this?

DENNIS LOCKHART, CEO AND PRESIDENT, FEDERAL RESERVE BANK OF ATLANTA:  Where am I?  Well, I’m more in the camp that patience is called for.  I’m holding to the view that mid-year 2015 is probably about the right time for the beginning of a cycle of tightening.  By that time, if all goes well, the economy will have made progress from where we are today and with a forecast of reasonably high confidence, look — will look like we’re going to achieve our objectives and so I’m not one who is — how should I put it — in a rush to really lift off soon.

I think the conclusions about the strength of the economy at this point have to be taken as tentative conclusions.  I’d like to see a bit more evidence accumulate.  So I’m still one of those who’s thinking in terms of the middle of next year.

I should emphasize that, of course, this is going to be based on the performance of the economy.  It’s data dependent.  It’s going to be a judgment that the committee makes, based on how things play out between now and year-end or early next year or even later.

So you know, it could be faster; it’s conceivable.  And therefore I might have to pull forward the date that I’m — have in mind.

But it also could conceivably be put off if things go badly.  So that’s the way I’m looking at it.  I’m still mid-2015.

HAYS:  Would you say it’s asymmetric at this point, though, that the — you and others are seeing, hmm, you know, the economy has improved.  It continues to improve.  We’re data dependent.

But it’s more of a question of not being so worried about the economy slowing down but just waiting to see how much it speeds up or how much is recovery gains momentum.

LOCKHART:  Well, it’s asymmetric in the sense that if people were sort of to handicap around midyear, whether it’s possible that liftoff would  come earlier or later, I think, that probably more people — including more of my colleagues — thinking it’s possible early.

So in that sense it’s asymmetric.

But I think we’re in a process of validating some assumptions and so far they seem to be playing out.

One key assumption is that after a really bad first quarter of the year and a second quarter that had some component of rebound from the first quarter, that we are on a track of round numbers 3 percent growth.  With all of the gains in employment and, for that matter, in prices that we would expect from that pace of growth, I think it’s still a little early to call that.

But the evidence certainly so far has been encouraging.

HAYS:  Would it be fair, though, to look at those minutes and say there has been, even a subtle shift on the FOMC, that there is this sense that more people are at least wondering, just wondering if maybe that — if the — that time has to shift forward a bit?

LOCKHART:  I think that’s a fair assessment.  Certainly there — I have colleagues who are either calling for an earlier notion of when liftoff would take place or are at least leaning more in that direction.

HAYS:  Forward guidance:  considerable period of time, apparently the minutes show a very — a very intense debate over that as well.

And obviously we know that one of your colleagues out and out dissented because he said it doesn’t reflect where the — where the — where the committee is now.

Is there any merit to that?

LOCKHART:  I think the guidance — and, of course, it’s considerable period of time after the ending of tapering — I think there is a mix of views on that.  My own view is that the terminology or the words are still appropriate.  And may very well be appropriate through the fall, depending on how the data come in.

So I’m not necessarily personally one who’s calling for change.  But clearly there are others who think that that guidance is — has sort of done its work and played its role.  And it’s time to adjust guidance.

HAYS:  Are you concerned the markets are watching the Fed so closely now that it — it’s difficult, almost not possible for the Fed to begin to start moving rates higher without an outsized market reaction, particularly — well, bonds, stocks, you name it.

LOCKHART:  Well, I think that’s  a question of how effective our communication is, once there is a consensus obviously about what has to be communicated.  And to what extent to this — to participants in the market understand what we’re saying and build their own positions around an anticipation that that’s the way things are going to play out.

Recently I looked at some information, both forward rates that — for both Fed funds and euro dollars and then looked at a — more of a consensus of forecasters of private sector forecasters.

There is some divergence between the rate path that the forecasters in their most recent survey had indicated and what the markets seem to have priced in.  You know, my hope would be that there’s a lot of consistency between what markets are pricing in, what forecasters are expected and what we’re saying.

If that’s the case, adjustment to higher interest rates should not have outsized turbulence associated with that move.  And that would be my hope.

HAYS:  You’ve said that you follow a kind of the “whites of the eyes” method on monetary policy, make sure the economy’s on sound footing before you make a move.

And so basically you haven’t seen quite enough whites of the eyes yet?  Or are you just kind of can barely see it, where would you — if you’re using that analogy —


LOCKHART:  Well, that expression may have been a little too cute.  What I was trying to convey is what I said a few minutes ago and that is that I’m prepared to be patient.  I want to evidence accumulate.  We have had — I’ll speak for myself — I have misread the potential for higher growth too many times.  I’m therefore a little bit cautious about declaring this economy to be on exactly the track we’re — we want and are expected.

Evidence certainly is confirming that it’s on that track.  But I want to wait a little bit longer and that’s what I was trying to convey with the “whites of the eyes” analogy.

So my approach to thinking about, let’s say, seeing the whites of their eyes, that kind of analogy, is that it’s very important that we have high confidence that the progress that we expect will be made over the next several months is going to continue.

So I’m trying to build up a sense of confidence in the forecast from the point at which we would begin to adjust forward guidance and then ultimately from the point of liftoff.

The forecast from that point is very important.  Liftoff in all likelihood is going to occur well before we actually achieved full employment and probably, you know, less than total certainty on long-term inflation, just because of the span of time.

So I want to be confident that the economy’s going to continue on that track.

HAYS:  What do you say to those who say you run the risk, the Fed, of waiting too long, of letting financial excesses or, you know, the seeds of inflation be planted?

LOCKHART:  In any policy stance, you know, there are potential costs or potential risks along with the gains that you’re expecting from putting policy in that position.  And I certainly would not be totally dismissive of the risks that would be associated with staying accommodative or ultra-accommodative too long.

But as I size things up, I just — I don’t see the situation developing that’s going to create enormous downside from a policy of staying the course until we have that confidence that I just spoke about and until we’ve achieved more absorption of the slack in the labor market.

HAYS:  Now in that piece, you gave a talk recently about liftoff.  And one of the things you said is that you do see that inflation’s starting to improve and employment — unemployment has come down.

But we obviously — wages rising, too.

Are you concerned that wages aren’t rising more?  And I’ve seen figures that would suggest if you look at annualized rates for some indicators of wage inflation, three months, six months, there is some acceleration now.

LOCKHART:  Well, let’s talk about wages.  Wages — there’s been very little indication so far that wages are rising.  I hear anecdotally about tight labor markets in certain professions and certain skill areas.

But overall, wages have been — continue at a very — a very tepid pace of growth.  And so we’re not seeing much indication in wages.  I don’t expect wages to foretell inflation.  I — or to be an early indicator.  If anything, they’re —


HAYS:  A lagging indicator, yes.

LOCKHART:  — a lagging indicator.   But still we have not seen much change in that — in that dimension of — so that — what was the second part of your question?

HAYS:  That in terms of what this means, I guess, for your overall view of labor market lack and how that’s adding up right now.

LOCKHART:  Well, one way to think about this is a little bit of a gimmick, I admit, but we’ve been in my — in my — with my staff, we’ve been talking about you threers and you sixers.  A you threer is someone who does not see a lot of slack and has taken, let’s say, taken a lot of encouragement from the reduction in the unemployment rate.

The you three unemployment rate, the conventional unemployment rate that is publicized by the Bureau of Labor Statistics.  I’m more of a you sixer.  I’m someone who wants to look at a broader set of indicators and when looking at those indicators, I see slack that I still think has potential to be absorbed if we stay the course with a bit longer with the policy we have in place.

HAYS:  So you’re worried that an interest rate increase, if it comes too soon, could derail the economy.

LOCKHART:  Derail is too strong a word.  You know, I think the economy is on its — on a pretty decent footing.  But I think there is some risk of moving prematurely and snuffing out some progress that otherwise could be made and, at the end of the day, would be deemed unnecessary.

HAYS:  Are you concerned about Europe?  We’ve seen more numbers coming out of Europe; Germany’s economy is slowing down.  Italy’s latest quarterly figure was negative, suggest recession.  And many other countries weren’t looking all that strong already.

Is Europe one of your concerns?

Will that affect your sense of the Fed’s first move on rates?

LOCKHART:  I would not factor at least Europe as we see it today greatly into our decision on the timing of liftoff.

Am I concerned about Europe?  I think we always have to be concerned about an economic bloc of that scale, certainly inflation is very weak and that’s reflective of the — of an economy that continues to be fairly stagnant.  I think that’s a concern for all of us, I mean, for the — for the whole world and certainly for the Europeans.

In June, the ECB took some action and lowered some rates.  But have not yet employed more aggressive tactics along the lines of quantitative easing.  There are technical reasons why that might not be the best thing for them to do.  It’s not my place to just what’s the right and wrong policy.

But at the moment, they are in a spell here of weak inflationary numbers and weak growth numbers and certainly I would be concerned if I were in their shoes.

HAYS:  What about the concern about financial excesses?  We had — we did have a selloff in the junk bond market, though people were getting pretty concerned about the tightness there.

Many have said, including the Fed chair, that there — that that has the tool of macroprudential regulation now.  So the Fed could monitor risk at the bank, make sure there is an excessive risk-taking.

You were many years a commercial banker.  So you know how banks really work.

Do you agree with that?

Is that — is that an effective tool now?

Can the Fed rely on that as you — as you wait to raise rates, gauge the economy or is that — is that risky in and of itself?

LOCKHART:  Well, I think the way to frame the question is, is it conceivable and would it be smart to raise interest rates to prick a bubble?  Or to somehow try to eliminate froth in financial markets?

I don’t think it’s a tool well adapted to that purpose.  Interest rates really operate through multiple channels and are — and have an — a much broader effect on the economy and there can be, at any given time, quite a distinction between what’s happening in the financial economy and what’s happening in the broad Main Street economy.

So I just don’t see monetary policy as our first resort for dealing with those kinds of risks or those kinds of developments.

Macroprudential tools, which operate most directly through the banking sector, certainly one recourse that we have to try to slow things down, but of course in our — in this country, a good portion of financial intermediation is outside the banking system.  So it’s not so directly treatable by macroprudential tools that have to do with bank supervision.

So there’s no perfect toolset, quite frankly.

At the same time — and this is — I do really want to emphasize this — I don’t see even with fully valued equity markets arguably or at least very highly valued equity markets and with other financial instrument markets that are really — have strong buying pressure, I’m not sure I see something that is systemic in its risk potential, something that’s likely to spill over broadly in the economy.

I think 2014 is not 2007.

HAYS:  Living wills:  Tom Hoenig (ph), who is now the second in command at the FDIC, who’s the former head of the Kansas City Federal Reserve Bank, I spoke with him — and of course he’s been pretty vocal; the FDIC has — and the Fed — last couple of weeks that the biggest banks in the country got an F.  They failed on the living will test.

What is your view?  Did — do the banks need to come back with more?

And again, as someone who was a commercial banker for many years?

LOCKHART:  Well, I don’t have direct knowledge or involvement with the larger banks on this.  So whatever I would have to say is indirect and obviously I support the position the Federal Reserve took.

As a former banker — and I worked in one of the country’s largest and most complex institutions — I certainly can understand the point of view of the regulators, that the table of organization, the legal vehicle table of any — of these institutions is extremely complex.  It spans multiple countries and is not an easy thing to take apart or simplify.

And so what I understand from — you know, for both press coverage and internal documentation, is that the first efforts on these living wills just didn’t credibly explain how they would actually prepare themselves for shrinking or for a bank kind of proceeding.

These institutions, in my opinion, are too complex and some of the assumptions apparently that they presented were dubious assumptions.

HAYS:  Should they hold more capital?  That’s another point that Tom Hoenig has made, that they really haven’t boosted their capital all that much, he says.  And it’s not just how much, it’s also the quality of capital.

Would you agree with that?

LOCKHART:  Well, I certainly think the — there has been improvement in capitalization, no question, both quality and quantity and as Basel 3 plays through with the surcharge for the larger banks, it — we’re going to see a situation with a much better picture from the point of view of capital.

The bigger debate is whether the banking system should be operating at just materially higher capital levels, which the banking system or the banks tend to resist strongly.  You know, they’re in the business of trying to return on their equity to their shareholders.  Even that is a debatable question because certainly there’s serious academic work that would suggest that markets can look through this to the risk profile of a bank and properly determine what kind of return should be expected.

But you know, having been a banker, I understand that you’re trying to run your business to ensure a return measure as well as an absolute profitability measure.

So this is yet to be worked out, I think.  If there’s going to be anything beyond what is already a down on paper.

HAYS:  Let’s talk about exit strategy.  That was also discussed at the last Fed meeting and whether it’s March or June or whatever, the key rates looks like there’s a sense that it’s going to be moved up next year.

And the next step will, I assume, be some delineation of the Fed about the exit strategy.

Do you have any early sense of what’s important in that, any part of that that you’ve — sort of could tell us about how you see this going?

LOCKHART:  Well, we’ve been using the term normalization and normalization is — was what appears in the minutes and that’s both the normalization of interest rates over a period of time and probably over and even a longer period of time.  The normalization of the scale of the Fed’s balance sheet.

So those are the two broad objectives that we’ve been planning for and discussing.  And what’s important there? Well, what’s important in my mind — the fancy word is monetary control — what’s important is we are able to influence short-term interest rates, which in turn influence longer-term interest rates when we’re prepared to begin to raise the policy rate.

And that’s in the context of a very large balance sheet, which is arguably a different set of circumstances than monetary policy has operated in in the past.

So it’s — in simple terms, it’s when we push the button, will what we want happen happen?  That’s the concern.

HAYS:  I’ve had a couple of guests mentioned recently that this is the question that’s really so interesting to the markets, certainly the bond market, of how the exit strategy is going to work.

I mean, people can argue about when the Fed should or shouldn’t move.  But clearly the key (INAUDIBLE) move tapering’s getting done.  So this is the next big thing.

Now they note that the minutes use this phrase about a reluctance to use the reverse repo facility.  What they’re noting is a temporary use on a limited scale.

Is there reluctance to use the reverse repo facility, do you think?

LOCKHART:  Oh, I think the minutes characterize the discussion appropriately and accurately.  The overnight reversed repo facility that’s proposed is a deposit facility, largely for non-bank institutions at the central bank.

If there were a substantial period — or a period of substantial stress, financial stress, the existence of such a facility might, under certain circumstances, exacerbate stress because it would create the potential to run to the central bank, arguably a safe place to put your money, and disintermediate other financial players in the market.

So we — you know, again, I agree with this point of view and this is what, I think, is reflected, is we don’t want to create something that under certain circumstances could worsen the situation as opposed to improve it.

HAYS:  It’s — but can you target the Fed funds rates successfully without robust use of the reverse repo facility?

LOCKHART:  I believe we can, quite frankly.  I believe that, first, we’re going to be — as has already  been characterized in the minutes — in all likelihood we’re going to be targeting a range.  So that’s — a range is going to allow some fluctuation which was always the case anyway, with the Fed — with the Fed funds rate.

I think when the interest and excess reserve rate is raised by an administrative decision and we announce a target range for the federal funds rate, I think that will substantially do the job.

HAYS:  And this is going to be how we gauge Fed policy, then?  That rate gets raised and the Fed’s tightening?

LOCKHART:  Correct.  It’s the wage — you know, the effectiveness of monetary policy should be gauged, and that is that the central bank is able to adjust the level of interest rates appropriate for this — for where the economy is at that time.

In the old days, before I joined the Federal Reserve, we had excess reserves of — they tell me $30-50 billion.  Today, $2.6 trillion or $2.7 trillion.  So it’s a different set of circumstances in which to conduct monetary policy.  And that’s why we’re being very careful about planning for the future.

HAYS:  Is that something that’s going to be more of an issue?  Or is there going to be a point where we’re worried?  Because it has been — it has been recently, but there — that concern has been raised, that at some point, that’s the tinder that’s waiting to get the match.  There’s all those reserves in there, boy, oh, boy, when banks start lending and that starts coming out of the banks, you — that’s when you could see the surge.  That’s when you could see the inflation pressures building.

LOCKHART:  Certainly in theory.  Excess reserves would translate into required reserves, which would reflect growth of credit.  And that’s the basic dynamic that would be at work.

The idea that credit is going to change overnight — and from, you know, one month to the next, explode — I find very farfetched — it’s a process.  We and everybody else will see that growth, will be able to adjust policy if we’ve — really feel the economy is overheating because of expanded credit.

So, again, I think the scenario that is painted of a sort of an explosive growth of credit because of someone lighting a match to the dry tinder of excess reserves is a little overwrought.

HAYS:  About how long is this process going to take, this process of getting back to how — if we can’t get back to how monetary policy used to be, over $2 trillion in excess reserves, a balance sheet, you know, that’s to the moon?

Is this — is this a decades-long —


LOCKHART:  — I think a multiyear process.  The — certainly the normalization of the balance sheet — and it won’t look like it looked in 2006.  I joined the Federal Reserve in 2007 about that time the scale of the balance sheet was $800 billion or $900 billion.

I think we’ll have — we’ll be in a new world and it will look different, as it no doubt should. But it will not be $4.4 trillion or $4.5 trillion, either, as it is today.

So I think it’s going to take some time; I don’t think it needs to be rushed.  It’s a grad process to normalize the balance sheet and get back to something like an all-Treasury asset side of the Fed’s balance sheet and to conduct monetary policy more through the Fed funds rate than through IOER.


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